Having previously taken a look at implied market expectations and analyst recommendations in previous articles, I thought it would be a logical next step to take a look at how the market was doing in comparison to analyst price targets. Since a small sampling of analyst recommendations suggested that the group tends to move as a herd, I once again wanted to see if the herd had decided upon any stocks with particular conviction - that is to say, a price target and/or recommendation that fell outside 2 standard deviations from the mean, one way or another. I was also interested to know if there was any positive correlation between price targets and recommendations, as well as which sectors were viewed most optimistically and which were falling into disfavor.
Though last time I worked with a small set of data, randomly selected by hand, this time I wanted to work with a larger set of data. I pulled the entire composition of the S&P 500 (NYSEARCA:SPY), breaking down the data by sector, then pulled analyst consensus price target information for each individual company, as well as data on expected EPS growth and historical EPS growth. I pulled from analysis 10-20 companies for which I was unable to quickly generate analyst consensus estimates. From there, I derived average prices, average price targets or fair value estimates, and a market-wide standard deviation for price/fair value estimate ratios.
|Price-to-Fair Value||Average Recommendation||Average Projected 1-Yr. EPS Growth||Average Projected 5-Yr. EPS Growth||Historical Growth Rate||Market Implied Growth Rate|
In the aggregate, the S&P 500's companies trade for about $60/share, on trailing twelve-month earnings of about $3.16 (for a Price-to-Earnings ratio of about 19 times). Even at these prices, though, when we take the aggregated fair value estimates for individual stocks, the S&P 500 trades nearly 10% less than analysts' average price targets, with the average market stock trading somewhere at 90.5% fair value or the 1-year price target. Analyst recommendations tend to be correlated well with these discounts, with a Pearson correlation coefficient of 0.46 (statistically significant for a population size of 480, with a two-tailed probability of 0.0005 at 0.147). Even when we account for the varying number of broker opinions available for each stock, the general 10% discount remains; weighted by analyst opinion, the stock market trades at 90.2% of its 1-year price target.
Sector breakdown goes a long way to generating some granularity. Though all sectors trade at a discount to fair value, the size of that discount is highly variable. Far and away, the Energy sector currently trades (as of Friday's close) at the largest discount to fair value, whereas utilities are pretty much fully valued. Materials come in a distant second place in terms of discount, and Consumer Staples appear to have achieved whatever aims analysts had held out for.
Sector outlooks also generate some interesting information. Aggregating individual outlooks based upon analyst consensus projections, the market as is expected to offer tepid 5%-6% 1-year earnings growth and 10% EPS 5-year CAGR overall, though that growth is expected to be both lumpy and heterogeneous. Explaining to a large degree the discounts in play, Energy faces extremely low expectations, as analysts expect a 20% average decline in EPS for the year and a piddling 2.8% EPS 5-year CAGR overall. Conversely, expectations are quite high for Materials, with analysts expecting 38%-39% EPS growth for this coming year and 20% overall EPS CAGR for the 5-year period. They are even more bullish on Healthcare, which is expected to grow over 42% EPS next year.
In the meantime, using reverse discounted cash flow estimates, the market seems to be implying, through its current prices, growth rates for the Consumer Discretionary sector that are more than 1000 basis points above its historical trend, and even overvalues the Energy sector by about 200 basis points of growth. The discrepancy is even greater for the Healthcare sector (1500 bps), though perhaps that's more forgivable than the market's expectations for Utilities (some 1200 bps above its 5-year EPS growth trend).
|P/FV Ratios for:||2 SD Above (Overvalued relative to mean)||1 SD Above||< 1 SD Above/Below||1 SD Below||2 SD Below (undervalued)||Composite Score|
Composite Score Key: 1 = High Conviction Discount, 5 = High Conviction Premium
Since most of us tend to think that the market is, if anything, fairly valued at present (if not over-valued), it seems fair to consider how current prices look in that context. If we take the market mean price-to-fair value ratio as fair (or "Hold"), and look for those companies trading at material discounts from even this recentered mean, a different picture emerges. (I define high-conviction or material discounts as a price-to-fair-value ratio over 2 standard deviations away from the mean P/FV ratio, and low-conviction or weak discounts as a P/FV over 1 SD away from the mean). Energy's composite rating of 1.70 is the best in this regard, with nearly every single company trading at a discount, and nearly half of those at material discounts to the market fair value. Though the Materials sector is expected by analysts to show torrid growth, the sector comes very lightly recommended, both in terms of actual recommendations and in terms of discount available. Utilities continue to trade at rich valuations, with most companies trading above the market P/FV ratio, and Consumer Goods (both Staples and Discretionary) appear to be trading at rich valuations (composite scores of 3.11 and 3.17, respectively).
The compiled data show that the run-up in prices over the past year or two has not sated analysts' expectations, as an aggregate analysis of individual price targets suggests that analysts believe that the market continues to be undervalued by about 10%. Expectations are lowest for the Energy sector, but even with these lowered expectations, analysts still clearly believe that a margin of safety may be found in a substantial number of large cap energy stocks. Conversely, Utilities and Consumer Staples are all but fully valued, even in comparison to analysts' rosy projections, and caution seems warranted in these names.
Non-energy names that pop up as trading well below their analyst consensus estimates and below the market mean include Genworth Financial (NYSE:GNW), Freeport-McMoRan Inc (NYSE:FCX), and Quanta Services (NYSE:PWR). Some caution appears warranted around Staples (NASDAQ:SPLS) and AutoNation (NYSE:AN), which trade well above analysts' fair value estimates.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: General Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. The author is not a professional financial adviser. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions.